How to Value CRE Rents After the Pandemic

Commercial real estate tenants are expecting and waiting for rents to drop. The industry is notoriously slow in responding to new market conditions, and most active players in the market, and either side of the table, are expecting pricing to come down over the next six to 12 months.

“Over the past few months, I have heard many tenants say the phrase ‘is that pre-COVID pricing?’ in response to a landlord quoted asking rent,” Xan Saks, partners and co-founder of Beta, tells GlobeSt.com. “From New York to Los Angeles, it is clear that there is an overwhelming belief by tenants—and prospective tenants—that commercial real estate rents have come down as a result of Covid-19. While it would certainly seem logical that mandated store and office closures, shelter in place orders, and continued uncertainty surrounding the virus would lead to reduced rents, the question we need to answer first is how do we value commercial real estate in a pre versus post COVID world?”

To find out if there has been a pricing change in rents, Beta tracked rent trends in all asset classes for the first half of the year. “We evaluated industrial, retail, and office product in Los Angeles County over the last four quarters with that last quarter evaluated being the start of the Covid-19 crisis in the United States,” says Saks. “We then evaluated the change in vacant square footage available as well as the average per square foot base rent, quarter over quarter. To ensure we are evaluating this question holistically, we also looked at the change is space available for sublease to account for tenants that may be trying to get out of their lease early, as well as total available square footage for lease to account for space that may become vacant soon.”

While tenants have an expectation of pricing change, it hasn’t come yet. According to the data, retail, industrial and office rents are all flat compared to the second half of 2019. “While these statistics appear to confirm that there has not been a material change in rents as a result of COVID, there is one other metric we evaluated which appears to be more telling about what is to come: leasing activity,” says Saks. “Leasing activity is defined as how many new leases were signed within the given quarter.”

Changes in leasing activity have been more telling, and generally serve as a precursor to changing rent trends. “There is a consistent, staggering outlier in this analysis within the last quarter when COVID hit the US. Transaction velocity was down, significantly, especially within the retail and office sector,” says Saks. “There appears to be a strong correlation between leasing activity and the COVID pandemic.”

If this trend holds, it will likely lead to increased vacancy and ultimately lower rental rates. In other words, the pricing change is still coming. “Instead of saying, ‘is this pre-COVID pricing?’, the better question for tenants to ask should be ‘is this asking rent based upon pre-COVID leasing demand,’” says Saks. “If tenants remain patient, decreased Leasing demand should eventually put pressure on landlord’s to reduce rent expectations to stay competitive within the market. For now, we will have to see who blinks first, the landlord or tenant.”